Activity-Based Costing (ABC) - is a systematic costing method that uses activities to allocate factory

overhead costs and other indirect costs to products. ABC can provide more accurate data on
product cost by using multiple cost drivers that reflect more accurately the causes of incurred
costs.

ABC vs. TRADITIONAL COSTING

Under the traditional costing, factory overhead costs are allocated to products by using a single
activity or cost driver (e.g., labor hours). In some accounting literature, traditional costing is also
called peanut-butter costing.

Under ABC, factory overhead costs are allocated to products using several activities or cost drivers
that are closely related with the incurrence of specific factory overhead costs.

STEPS IN IMPLEMENTING ABC:

a. Perform PROCESS VALUE analysis - identifying value-added vs. non value-added activities.
: A value-added activity is a non-eliminable activity that incurs costs but increases the worth of
the product to the customer. (e.g., engineering designs modification)
: A non value-added activity increases the cost of a product but does not increase its value to
customers. ( e.g., materials handling and rework)
b. Identify cost drivers (activities), cost pools and activity centers.
: A cost driver is the particular activity that causes the incurrence of certain costs.
: A cost pool is a group of similar costs usually increased or decreased by a single cost driver.
: An activity center is a unit of organization that performs a set of tasks. It is a part of the
production process for which management wants a separate reporting of the cost of the activity
involved. Level of activity centers can be classified into four general categories:
i. Unit-level activities - performed each time a unit is produced
ii. Batch-level activities - performed each time a batch of goods is handled or
processed
iii. Product-level activities - performed to support production (sales) of specific
product type
iv. Facility-level activities - performed to sustain a facility's manufacturing process
c. Calculate predetermined overhead rates for each identified activity
Predetermined overhead rate = Estimated overhead costs / Estimated activity level
NOTE: Estimated figures are used because actual figures are not yet known at the start of the
period.
d. Allocate overhead costs to the products on the basis of predetermined overhead rates.

In summary, ABC is a 'two-stage' allocation process. First, overhead costs are traced to activities; then,
overhead costs are allocated to products on the basis of the activities performed by a particular product.
1. ABC systems are characterized by their use of which of the following measures as bases for allocating
overhead to output:
a. Unit-level drivers
b. Batch-level drivers
c. Product-level drivers
d. All of the choices
2. Examples of activities at the batch level of cost include:
a. Scheduling, setting up and moving
b. Cutting, painting, and packaging
c. Designing, changing, and advertising
d. Heating, lighting and security
3. Any activities that causes resources to be consumed is called:
a. Just in time activity
b. Facility level activity
c. Cost driver
d. Non-value added activity.
4. Activity based costing:
a. Can be used only in a process cost system
b. Focuses on units of production
c. Focuses on activities performed to produce a product
d. Uses only a single basis of allocation
5. Traditional costing system are characterized by their use of which of the following measures as basis
for allocating overhead costs to output:
a. Unit-level drivers
b. Batch-level drivers
c. Product-level drivers
d. Plant-level drivers
6. An accounting system that collects financial and operating data on the basis of the underlying nature
and extent of the cost drivers is
a. Direct Costing
b. Activity-based costing
c. Cycle-time costing
d. Variable Costing
7. Which of the following is true?
a. The traditional approach to costing uses many different cost drivers.
b. Costs that are indirect to products are by definition traceable directly to products.
c. Costs that are indirect to products are traceable to some activity.
d. All of the statements are true
8. Process value analysis is a key component of activity-based management that links product costing
and
a. Reduction of the number of cost pools
b. Continuous improvement
c. Accumulation of heterogeneous cost pools
d. Overhead rates based on broad averages
9. A(n)________________ method first traces costs to a department then to products
a. Direct costing
b. Absorption costing
c. Traditional costing
d. Activity-based costing
10. An objective of activity-based management is to
a. Eliminate the majority of centralized activities in an organization
b. Reduce or eliminate non-value-added activities incurred to make a product or provide a
service
c. Institute responsibility accounting systems in decentralized organizations
d. All of the choices

e. Traditional overhead allocations

result in which of the following
situations?
f.a. Overhead costs are assigned as
period costs to manufacturing
operations.
g. b. High-volume products are
assigned too much overhead, and
low-volume products are assigned
too little overhead.
h. c. Low-volume products are
assigned too much, and high-volume
products are assigned too little
overhead.
 i. d. The resulting allocations cannot be
used for financial reports.
11. Traditional overhead allocations result in which of the following situations?
a. Overhead costs are assigned as period costs to manufacturing operations
b. High-volume products are assigned too much overhead, and low-volume products are
assigned too little overhead.
c. Low-volume products are assigned too much, and high-volume products are assigned too
little overhead
d. The resulting allocations cannot be used for financial reports.
12. Which of the following is not a sign of poor cost data?
a. Competitors’ prices for high-volume products appear much too high
b. The company seems to have a highly profitably niche all to itself
c. Customers don’t balk at price increases for low -volume products
d. Competitors’ prices for low=volume products appear much too high
13. In Activity-based Costing, which of the following would be considered a value-added activity?
a. Repair of machines
b. Engineering designs
c. Bookkeeping
d. Storage of inventory
14. ABC should be used in which of the following situations?
a. Single-product firms with multiple steps
b. Multiple-product firms with only a single process
c. Multiple-product firms with multiple processing steps
d. All of the choices
15. Products make diverse demands on resources because of difference in all of the following except?
a. Volume
b. Selling Price
c. Batch Size
d. Complexity
16. Which of the following add customer value?
a. Setup time
b. Storage time
c. Idle Time
d. Processing Time

17. Which of the following is typically regarded as a cost driver in traditional accounting practices?
a. number of purchase orders processed
b. number of customers served
c. number of transactions processed
d. number of direct labor hours worked
18. Cost allocation bases in activity-based costing should be
a. cost drivers.
 b. value-added activities.
c. activity centers.
d. processes.
19. Traditionally, managers have focused cost reduction efforts on
a. Costs
b. Activities
c. Processes
d. Departments
20. Relative to traditional product costing, activity-based costing differs in the way costs are
a. Processed
b. Allocated
c. Benchmarked
d. Incurred
21. Lebanon manufactures two versions of a product. Production and cost information show the
following:
Model A Model B
Units produced 100 200
Material moves 10 40
Direct labor hours per unit 1 2

Under ABC, the materials handling costs of P 100,000 allocated to a unit of Model B is:
a. P 10 c. P 333
b. P 200 d. P 400

22. Iran Manufacturing produces three products. Production and cost information show the following:

Model F Model A Model Q

Units produced 1,000 3,000 6,000

Direct labor hours 2,000 1,000 2,000
Number of inspections 20 30 50
Using direct labor hours as the allocation base, the inspection costs of P 50,000 allocated to each
unit of Model F would be
a. P 5.00 c. P 20.00
b. P 10.00 d. Some other number

23. McMahon Company would like to institute an activity-based costing system to price products. The
company's Purchasing Department incurs costs of P550,000 per year and has six employees.
Purchasing has determined the three major activities that occur during the year.
Allocation # of Total
Activity Measure People Cost
Issuing purchase orders # of purchase orders 1 P 150,000
Reviewing receiving reports # of receiving reports 2 P 175,000
Making phone calls # of phone calls 3 P 225,000
 During the year, 50,000 phone calls were made in the department; 15,000 purchase orders were
issued; and 10,000 shipments were received. Product A required 200 phone calls, 150 receiving
reports, and 50 purchase orders. Product B required 350 phone calls, 400 receiving reports, and
100 purchase orders.

The amount of purchasing department cost that should be assigned to each of these products
are:

a. Product A = P 9,575; Product B = P 4,025

b. Product A = P 4,025; Product B = P 9,575
c. Product A = P 2,625; Product B = P 8,575
d. Product A = P 8,575; Product B = P 2,625
24. Refer to the McMahon Company, what is the purchasing department cost per unit if 1,500 units of
Product A and 3,000 units of Product B were manufactured during the year.
a. Product A = P 2.68 ; Product B = P 3.19
b. Product A = P 3.19 ; Product B = P 2.68
c. Product A = P 3.19 ; Product B = P 5.72
d. Product A = P 5.72 ; Product B = P 3.19
25. Queen Company incurs about P860,000 in manufacturing overhead costs each month which had
been allocated to individual product lines based on their relative shares of direct labor hours (DLH).
The company works about 100,000 DLH per month. The company is concerned that using DLH is
inappropriate because some costs are driven by ither activities. The following information regarding
cost pools and drivers has been developed:

Cost Driver Amount In Pool Amount of Activity

Direct labor hours P520,000 100,000
Number of batches P280,000 500
Engineering/design changes P60,000 120
Total over head costs P860,000

The following data regarding two product lines of the company are presented:

Product A Product B

Direct labor hours 1,600 200

Number of batches 4 12
Engineering/design changes 2 24
Product A are produced in large batches, while Product B are as specialty line that only few customers
buy.
What is the overhead to be allocated to product A using the DLH as the only cost driver?
a. P 13,760
b. P 14,000
c. P 14,760
d. P 13,270
26. What is the overhead to be allocated to product B using ABC?
a. P 14,760
b. P 11,560
 c. P 19,760
d. P 14,670
27. Mega Enterprises is a Philippine exporter of souvenir items manufactured in the capital city of Cebu.
The following overhead cost data has been accumulated:

Activity Center Cost Driver Amount of Activity Center Costs

Materials handling KLS handled 100,000 Kls P 50,000
Painting Units Painted 50,000 units P 200,000
Assembly Labor Hours 4,000 hours P 120,000

Job 1 contains 3,000 units. It weighs 10,000 kls and uses 300 hours of labor.

What is the total overhead cost assigned to Job 1 using ABC?

a. P 26,000
b. P 32,000
c. P 27,750
d. P 31,900
28. A company keeps 20 days of raw materials inventory on hand to avoid shutdowns due to raw
materials shortages. Carrying costs average P2,000 per day. A competitor keeps 10 days of inventory
on hand the competitor's carrying costs average P1,000 per day. Value-added costs are:
a. P 40,000
b. P 20,000
c. P 10,000
d. P 0
29. Rare Cosmetics has used a traditional cost accounting system to apply quality control costs uniformly
to all products at a rate of 14.5% of direct labor cost. Monthly direct labor cost for Satin Sheen
makeup is P27,500. To distribute quality control costs more equitably, Rare Cosmetics is considering
activity-based costing. The monthly data shown in the chart below have been gathered for Satin
Sheen.

Activity Cost Driver Cost Rates Quantity

Incoming material inspection Type of Materials P 11.50 per type 12 types

In-process inspection Number of Unit P 0.14 per unit 17,500 units
Product certification Per Order P 77 per order 25 orders

The monthly quality control cost assigned to Satin Sheen makeup using activity-based costing is
a. P88.64 per order.
b. P525.50 lower than the cost using the traditional system.
c. P8,500.50
 d. P525.50 higher than the cost using the traditional system.

30. Yuna Company uses activity-based costing. The company produces two products: coats and hats. The
annual production and sales volume of coats is 8,000 units and of hats is 6,000 units. There are three
activity cost pools with the following expected activities and estimated total costs:

Activity Estimated Expected Expected Total

Cost Pool Cost Activity Activity
Coats Hats
Activity 1 P20,000 100 400 500
Activity 2 P37,000 800 200 1,000
Activity 3 P91,200 800 3,000 3,800
Refer to Hazel Company. Using ABC, the cost per unit of coats is approximately:
a. P 2.40
b. P 3.90
c. P 6.60
d. P 10.59
31. Refer to Hazel Company. Using ABC, the cost per unit of hats is approximately:
a. P 2.40
b. P 15.90
c. P 12.00
d. P 10.59

32-35:
San Jose Construction manufactures and installs standard and custom-made cabinetry for residential
homes. Last year, the company incurred P200,000 in overhead costs. After implementing activity-based
costing (ABC), the company's accountant identified the following information:
Activity Allocation Base Proportion of Overhead Cost

Materials delivery & handling # of deliveries 30%

Inspections # of inspections 25%
Supervision hours of supervisor time 20%
Purchasing # of purchase order 25%

The number of activities for standard and custom-made cabinets is as follows:

Standard Custom-made
Number of deliveries 200 100
Number of inspections 600 400
Hours of supervisor time 1,800 2,200
Number of purchase orders 1,000 1,000
During the past year, San Jose accepted a customer order for a set of custom-made cabinets that
would require the following:
 Direct labor cost (25 hours at P 15 per hour) P 375
Direct materials (wood) (900 ft at P3 per foot) P 2,700
Number of deliveries 3
Number of inspections 5
Hours of supervisor time 5
Number of purchase orders 3

1. How much overhead should be applied to the above customer order?

2. What is the total product (manufacturing) cost for the above customer order?

An accounting system that collects

financial and operating data on the basis
of the underlying nature and extent of the
cost drivers is
An accounting system that collects
financial and operating data on the basis
of the underlying nature and extent of the
cost drivers is
An accounting system that collects
financial and operating data on the basis
of the underlying nature and extent of the
cost drivers is